This moment right now has all the makings of being homerun city for people to buy new CRE assets. This week the Kansas City Federal Reserve holds an annual conference where most of the people who do global banking, economists, and the press attend. It’s always held in Jackson Hole, WY. The Federal Reserve Chair, Jerome Powell spoke this morning and his keynote speech had everyone on the edge of their seats.
Inflation by all measures has been cooling heavily this summer. 2.5% last month vs 7.1% July 2022.
The economy appears to be undulating a bit
Investors are getting more anxious about the stock market
Retailer sales are mixed
Unemployment is ticking up steadily
For all intents and purposes, it appears we are headed or are already in a recession. Recession = A fall in GDP in two successive quarters
The problem is that for 2023, 22.7% of GDP was government spending. Per the Bureau of Economic Analytics as of Q32023, 36.2% of GDP is government spending. How can we really tell what is happening “truly” with GDP and where it is headed when more than 1/3 of it is manipulated by the government.
Jerome Powell Speech Highlights:
“The time has come for policy to adjust”
“The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
“My confidence has grown…that inflation is on a sustainable path back to 2%”
So what are my take aways here on a Friday am.
FAMILY OFFICE:
There has quite literally never likely been a better time for you to acquire your next property than right now. As interest rates have climbed over the last two years net leased retail has followed right along. Now that we are two years after the initial rate hikes most merchant retail developers have woken up and smelled the coffee and either figured out how to place permanent financing on their underwater project or they have cut the pricing to a market rate and are selling it. You are looking for the latter. Those offices that are stuck with a bad asset are your opportunity.
Daniel Herrold’s [Northmarq] provides me a monthly data set of all available Starbucks properties across the US and all sales comps. Per his August report, there are 228 available Starbucks locations in the US. That is a massive increase of 104% from when Daniel first started tracking the data in January 2023. There are approximately 10 deals per month. Meanwhile last month 22 new Starbucks hit the market for sale. So what has happened to SBUX cap rates since January 2023? You guessed it they are much higher.
January 2023
Starbucks Asking Cap: 4.71%
Starbucks Available Properties:112 Stores
August 2024
Starbucks Asking Cap: 5.42%
Starbucks Available Properties: 228 Stores
The August 2024 Starbucks report indicates a 5.54% sold cap rate over the prior 30 days. Over 19 months of data collection ~10 stores are sold per month. 22 new available Starbucks hit the market last month.
The numbers look similar when comparing Starbucks to many other national retailers.
January 2023
Dutch Bros Asking Cap: 4.56%
Dutch Bros Available Properties:42 Stores
August 2024
Dutch Bros Asking Cap: 5.06%
Dutch Bros Available Properties: 72 Stores
With the caps elevated due to increased inventory, this presents a great moment for you to make your next acquisition. If the Fed in fact starts to reduce interest rates, then the lending rates will come down at the local banks and life insurance companies that finance the majority of these deals. That will cause more liquidity to come back into the market and will start to reduce the inventory of available properties. Thus in turn the cap rates will have downward pressures. This has the making of a great buy opportunity.
SYNDICATOR:
Happy hunting if you syndicate deals in the industrial or retail space. Anything with a price tag over $5MM has had weird pricing during the last 2 years. Unless there was a situation where a property owner had financing or other pressures, we are seeing pricing all over the place. Most of our syndicator friends are seeking deals where the acquisition cap rate is 150 – 200 bps or less than the current 5-year borrowing rate. Most 5-year money syndicators use is either priced off the SOFR rate or another index for regional banks like the FHLB rate.
SOFR rate is 5.31% as of August 22, 2024*
Banks quote 7.25-7.75% depending on customer relationship
DESIREDCAP RATE for syndicators = 8.75% - 9.75%
Well, how many 9-cap deals have you all been looking at over the last 2 years? My guess is not many. Pro is you have likely gotten 1-2 strokes off of your golf handicap. Con is that you are likely bored if you are in the same boat as many of my friends. With the high likelihood of the Fed cutting rates, we could see many of our syndicators banking on that, increasing their buying appetite down 100 – 150 bps, and starting to hunt in the 7.25 cap rate+ range. If you are playing ball aggressively this is a great move. You can mitigate some of your exposure here by extending your hold time to 7-10 years vs modeling a 5-year hold.
DEVELOPERS:
If you are a developer, you are still solvent and you are reading this then congratulations. You have made it to this point. You have survived COVID. You have survived Various Supply Chain problems. Most importantly you have survived a big a** rate hike. Developers work on a spread. The constant measure as to whether they choose to move forward on a deal or not is determined by looking at projected income / total cost. That unleveraged yield on cost equation tells them what their “return” is going to be. The next important factor for any developer to figure out is what is the end value of the asset going to be once they are done building it. That delta between the end cap rate value of the property and the unlevered yield on cost is the developer's spread. Well, when the Fed raises the Fed funds rate 500 bps over 16 months that’s a real problem. All the loans that get extended to developers in some way or fashion are tied back to the Fed Funds Rate. So many of the buildings that have been getting delivered during the last 2 years have had no margin or the developer is underwater meaning the property is not worth what they have spent to build it.
This has caused a large number of retail merchant developers to be sitting stalemate and not pursuing new projects. Hard to think about new projects when your banks are calling you asking you what your plan is on a new 7-Eleven that you just built for $7,000,000 and is now only worth $5,250,000. This is not a fun time for our peers who have any number of buildings that fit this criteria. Lots of investors have equity in projects like those as well. This may cause a lot of these investors to be fearful of pursuing any new opportunities. This is understandable, but a bad take in my opinion.
This moment right now is when times look pretty for a merchant retail developer.
The Fed is indicating to you that they are going to drop rates.
Retailers are frustrated because they have not been hitting store growth objectives for a few years now.
Banks are frustrated because they have not been loaning money out in the volume they would like to.
If the Fed drops rates, then that will encourage more liquidity to come into the system. As happens there will be more buyers than there have been for the last couple of years pushing inventories down. As inventories come down and borrowing rates cap rates will follow shortly after and have downward pressure.
Happy hunting to the developers. If you are an LP in the merchant retail development world this could be some of the better investments, you make. The market appears ripe for the picking around the horn.
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